MBOs: Making a planned exit

Selling a business isn’t simple, but a management buyout can offer a neat solution.

Whether through retirement, family circumstance or death, private businesses move on. Owners looking for an exit can work with corporate finance advisers or approach competitors. Another solution, though, is a management buyout (MBO).

Defining an MBO

Paul Taylor, a partner at Fox Williams LLP, explains that at its simplest, a management buyout is “the acquisition of a business, in whole or part, by its management team”.

It usually involves the provision of debt and/or equity funding by a bank and/or private equity investor. “Sometimes,” adds Mr Taylor, “a new management team will be brought in, or other times it can be a mixture of existing and new management.”

Samantha Chaney, a partner in the corporate team at law firm VWV, has seen owner-managers plan MBOs many years in advance, bringing trusted staff into management to aid succession planning. She says owners see MBOs “as the conclusion of a long-term strategy to grow and push the business forward whilst keeping the business within the hands of those that know it best”.

Why an MBO?

Mr Taylor reckons there is no correct route to exit, and the format depends on several variables, such as the current state of the business, its attractiveness to debt and equity providers and the appetite of management teams. 

He adds that one common reason for going down the MBO route is stability, as “key management team members will continue in office with minimal disruption for customers and suppliers.”

He describes MBOs as a “well-trodden path,” adding that private equity firms often have deal teams and documents “on the block ready to go”, as well as readily available funding for the right opportunity. Success isn’t automatic, but Ms Chaney thinks it’s highest when an owner has trust and confidence in the management team. She says: “It is natural that during an MBO sellers have concerns that the buyer may be taking steps to devalue the company.

“However, it is unlikely to be possible to impose restrictions on management to avoid taking actions which might devalue the business because it could impede their work. It is also not an ideal starting point for negotiations.”

Mr Taylor says he has witnessed management teams “sabotaging” a sale process involving competing third party purchasers to ensure their MBO bid goes through. “It’s the exit equivalent of a disgruntled divorcing spouse leaving the matrimonial home in a terrible mess to put off potential buyers,” he says.

Ms Chaney advises owners to rely on the terms of employment contracts or service agreements entered into by the management where there are requirements to act in the best interests of the business.

The process

Many MBOs are initiated by owners. However, a management team may raise the matter if it believes an owner is losing interest in the business or is starting to look at alternative routes for sale. And, of course, if the business has private equity or venture capital involved, the discussion may arise naturally as it should be obvious that investors would have had an exit strategy from the outset.

Every sale requires negotiation, and an MBO is no different. To ease the process, Ms Chaney recommends that owners consider appointing a corporate financial adviser to help explore all possible sale options and project manage the sale. 

She warns there is much at stake: “If negotiations don’t go well, the seller risks the morale and commitment of the current management team. This may restrict a sale via an alternative route in the near term as any resulting changes in personnel need time to bed down and prove successful.”

Another risk comes from sellers pulling out against the wishes of the MBO team.

Timescale

In Mr Taylor’s experience, “a typical time frame is two to three months from when heads are signed to actual closing.” He bases this on there being three distinct processes: the share purchase agreement and disclosure; a shareholder’s agreement and articles of association being negotiated between the continuing management team and private equity backers; and the provision of lending and security documents if debt is being provided to part or fully fund the exit.

Non-management sellers may have to offer operational warranty protections to give succour to buyers. Mr Taylor says this makes sellers “very reliant on management to make sure that a proper disclosure process is carried out.”

As with many private equity deals, the use of warranty and indemnity insurance can be used to plug gaps. “It may be that taking out a policy is in the best interests of all,” says Ms Cheney, “as the risk of claims is low because of management’s existing knowledge, but should one arise then the financiers are protected.”

Sellers must be realistic about the price and the deal structure when going through an MBO. If there is too much financial pressure placed on the management team at the outset, the business can suffer. And if part of the purchase price is dependent on future performance, the seller will lose out in the long run.